Why diversification is key to protecting your wealth when inflation rises

Inflation is an important factor in your long-term financial planning. To stay ahead of rising costs and maintain the purchasing power of your assets, your investments will need to provide good returns.

Inflation is at 10.1%

Although the Bank of England (BoE) targets inflation rate is 2%, inflation is currently at 10.1% – the first time we’ve seen double digits since 1982. At these rates, to keep up with inflation investors need a portfolio with the potential to deliver the best returns possible in order to maintain the purchasing power of their money.

This can be a challenge – especially if you have little exposure to stocks and shares and instead hold a lot of your money in cash or bonds.

Inflation is usually transitory, but investors should focus on the long term

Of course, when you invest, you should be doing so with a long-term view and the inflation that we're experiencing at the moment will, hopefully, prove to be transitory.

Indeed, the BoE is already taking steps to reduce inflation. One way it is working to achieve this is by raising interest rates. This increases the cost of borrowing but it's a tricky balancing act as the Bank doesn't want to slow the economy too much.

However, the effects of raising interest rates won't be seen immediately. And, whatever happens to inflation, taking steps to mitigate its effect on your wealth is sensible planning.

Diversification can help protect the purchasing power of your money

One way to protect the long-term purchasing power of your money is to ensure that you make clever use of diversification in your investment portfolio.

While a diversified portfolio doesn’t automatically guarantee that you’ll be protected from losses, it can help lower your risk. This is because the values of different types of assets don’t always behave the same way or move in the same direction.  

By holding a diversified portfolio, a fall in the price of one investment will have less effect overall.

Don’t put all your eggs in one basket

Put simply, diversification means “don’t put all of your eggs in one basket”.

A well-diversified portfolio will spread your wealth over different types of investments and asset classes. This avoids having a concentration of funds in one place. A diversified portfolio might, for example, invest across cash, equity, bonds, commodities, and property.

As well as being a useful way to protect your money from the effects of inflation, diversification is also a useful risk management strategy. In the event of significant market volatility, holding a diverse portfolio may reduce your chances of incurring major losses.

Diversification isn't just about spreading your money between different stocks or placing half your funds into a different savings account.

Asset classes respond differently to market factors

The ultimate aim should be to spread your wealth over different asset classes to give you a strong, well-balanced portfolio.

Because asset classes are all affected by market factors differently, a diverse range of investments is more likely to provide relatively stable growth.

As an example, property investments traditionally perform well when interest rates are rising. Meanwhile, bonds or fixed-rate investments, are susceptible to high interest rate environments because they are static, and this causes them to fall behind the market rate.

If your portfolio is heavily weighted towards bonds, you would likely experience a bigger loss of value than if your money was split between bonds and some property interests, which could help to balance out the negative impact.

When investing in stocks and shares, you can also diversify across specific regions, sectors, themes and even company size. For example:

• Geographical regions such as the US, UK, Europe, Asia or Japan

• Sectors such as finance, energy, transport or consumer

• Themes such as technology, healthcare, renewable energy

• Size such as smaller companies (small cap) or larger companies (large cap).

How we can help you to stay ahead of inflation

Most investors need a well-balanced combination of investments to provide the returns required to meet long-term goals.

To stay ahead of inflation, we look at your investment mix as a whole and evaluate where you stand. We revisit your investment portfolio on a regular basis to ensure that you hold investments in the right balance to suit your goals and appetite for risk.

Get in touch

If you’re concerned about the effects of inflation on your investments and want to ensure that your portfolio is well-diversified and balanced according to your financial goals, please get in touch. Email enquiries@alexanderpeter.com or call us on +44 1689 493455.

Please note: The content of this newsletter is offered only for general informational and educational purposes. It is not offered as and does not constitute financial advice.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

You might also be interested in:

Investments
Everything you need to know about the “emergency mini-budget”
Employment
5 positive health habits from around the world that other cultures can teach you
Pensions
How to find lost pensions, savings, and other forgotten money
Pensions
5 practical ways to protect your pension savings in challenging times